Internal Revenue Code Section 401(k) allows an employer to establish a retirement savings plan which permits owner(s) & employees to voluntarily direct a maximum of $13,000 (indexed) during the 2004 calendar year) into the plan BEFORE it is federally (and state) taxed.

Personal 401(k) contribution limit is $13,000 (2004 indexed). Individuals age 50 and older by December 31, 2002 will be permitted to make an additional $1,000 "catch up" contribution to 401(k) plans. Plan limit for 401(k) contributions is 100% of compensation (subject to the above dollar limitations & deductions for payroll/Social Security taxes).

Your tax-deferred contributions are credited to your own account, which is invested in your designated investments, and the earnings are reinvested also without being subject to current federal (or state) taxation.  Funds are generally withdrawn during retirement and taxed (if taxable) at lower income tax rates.  Funds may also be withdrawn prior to retirement under certain circumstances.

Effective in 2002 - 2007 there is a new "saver's credit" which is an income tax credit that is available to eligible taxpayers who contribute to a retirement plan.  The saver's credit rate is based on the taxpayer's adjusted gross income for the taxable year for which the credit is claimed, as follows:

Adjusted Gross Income

For example, a taxpayer whose filing status is single with adjusted gross income of $15,000 may be entitled to a credit equal to 50% of his or her contributions (up to $2,000 of contributions) to a plan.